clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. Holmes plc announces that it is going to issue additional perpetual debt, with promised interest payments of £1,200. The funds generated will be used to make a one-off payment to equity holders and there will be no other impact on expected cash flows. Calculate the value of Holmes’ equity after the transaction described above has been undertaken.

clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. Holmes plc announces that it is going to issue additional perpetual debt, with promised interest payments of £1,200. The funds generated will be used to make a one-off payment to equity holders and there will be no other impact on expected cash flows. Calculate the value of Holmes’ equity after the transaction described above has been undertaken.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 7P

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clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. (a) Assume that both firms are correctly priced by financial markets in accordance with the Modigliani and Miller theorem. What is the expected rate of return on equity for the two firms? (Hint: you will need to calculate the expected cash flow for the firm and use…
clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. Assume that both firms are correctly priced by financial markets in accordance with the Modigliani and Miller theorem. What is the expected rate of return on equity for the two firms?
clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. What are the reasons why debt capital in a firm typically has a lower cost of capital than does equity capital in the same firm?
clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs.Discuss the view that capital structure is irrelevant to firm value.
Clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000.The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs.Holmes plc announces that it is going to issue additional perpetual debt, with promised interest payments of £1,200. The funds generated will be used to make a one-off payment to equity holders and there will be no other impact on expected cash flows. Calculate the…
Clacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. (a) Assume that both firms are correctly priced by financial markets in accordance with the Modigliani and Miller theorem. What is the expected rate of return on equity for the two firms? (Hint: you will need to calculate the expected cash flow for the firm and…
clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. (a) Assume that both firms are correctly priced by financial markets in accordance with the Modigliani and Miller theorem. What is the expected rate of return on equity for the two firms? (Hint: you will need to calculate the expected cash flow for the firm and use…
lacher plc and Holmes plc are two firms with identical prospects regarding their future cash flows. The cash flows are expected to remain constant forever into the future. The market assesses the prospects of the two companies and believes that there is a 30% probability that the cash flow will be £20,000 and a 70% probability it will be £40,000. The firms are the same in all respects except for their capital structures. Clacher is entirely financed by equity capital, while Holmes has perpetual riskless debt outstanding with an annual interest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return in the economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs. (a) Assume that both firms are correctly priced by financial markets in accordance with the Modigliani and Miller theorem. What is the expected rate of return on equity for the two firms? (Hint: you will need to calculate the expected cash flow for the firm and use…
Clacher plc and Holmes plc are two firms with identical prospects regarding their future cashflows. The cash flows are expected to remain constant forever into the future. The marketassesses the prospects of the two companies and believes that there is a 30% probability that thecash flow will be £20,000 and a 70% probability it will be £40,000.The firms are the same in all respects except for their capital structures. Clacher is entirelyfinanced by equity capital, while Holmes has perpetual riskless debt outstanding with an annualinterest payment of £6,000. Clacher’s equity is valued at £200,000. The risk-free rate of return inthe economy is 10%. There is no taxation, and there are no agency costs or bankruptcy costs.(a) Assume that both firms are correctly priced by financial markets in accordance with theModigliani and Miller theorem. What is the expected rate of return on equity for the two firms?(Hint: you will need to calculate the expected cash flow for the firm and use…
Wham Corp. is financed entirely by equity at the cost of 12%. The firm is expected to generate a level, perpetual stream of earnings of $1,000 per year. It operates in a perfect market except for taxation at the rate of 40%. (a) Compute the net cash flow per year and the value of the unlevered firm. (b) Now assume the firm borrows $3,000 at a debt cost of 8%. (c) Compute the value of the levered firm and account for the difference in your answer for the unlevered firm.
A firm has two independent projects, each requiring investment of INR 3 million, but each of these have different risk profiles, i.e., different costs of capital as below: Project A 17%, Project B 7% IRRs for A and B are 20% and 9% respectively. The firm would maintain a 30:70 debt-equity ratio and expects its net income to be 6 million INR. If this firms maintains a residual dividend policy (all cash distributed as dividends), what will be the pay-out ratio for this firm?
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